Should Low Oil Prices Be Even Lower?

The Brent crude market has slipped into ‘contango’ and the prices for future delivery exceed current spot prices, but MoneyShow’s Jim Jubakpoints out that supply could be even further ahead of demand than markets anticipate.

It’s not like oil and natural gas stocks need more bad news. But strategies in the futures market suggest that today’s low oil prices should actually be lower.

Today, in its September monthly report, the International Energy Agency cut its forecast for global oil demand growth for 2014 to 0.9 million barrels a day and for 2015 to 1.2 million barrels a day. Demand for 2015 is now forecast at 93.8 million barrels a day. Global supply dropped to 92.9 million barrels a day, a decline of 400,000 barrels a day, as an increase in supply from Libya didn’t quite make up for lower production from Saudi Arabia and Iraq.

The big culprits on the demand side are a continued near-recession in the EuroZone and a weaker outlook for growth in China.

Yesterday, West Texas Intermediate, the US benchmark, and Brent, the European benchmark, hit lows not seen since April 2013. Today, crude has recovered slightly on news that Saudi Arabia cut production by 408,000 barrels a day in August and speculation that the country might cut production more to support oil prices.

But there’s offsetting—or worse—news from the futures market for Brent crude. That market has slipped into a condition called ‘contango,’ where prices for future delivery exceed current spot prices. That has led traders to buy oil today and put it in storage in the hope of selling it forward at higher future prices.

About 50 million barrels of crude are now being held in storage on tankers off South African and Asia, according to consultant’s Energy Aspects. That’s the highest level since the contango of 2008-2009. This week, the oil markets were roiled by reports that a Chinese buyer had chartered the world’s largest tanker to store oil.

Numbers put together by the International Energy Agency show that crude inventories rose to 2.67 billion barrels in July, the highest level since September 2013. If all that oil stored in tankers is captured by the International Energy Agency inventory numbers, then no big deal. Everybody knows there’s a lot of oil in storage and that should be reflected in current oil prices.

But history suggests that the official data doesn’t capture all the oil that’s in storage. If that’s the case, then supply is even further ahead of demand than the markets anticipate in crude prices. Oil prices would—therefore—come under pressure as this unanticipated oil hits the markets.

Like so much right now, oil prices are data dependent. The reason that the future price of oil is above the current spot price is a belief that the sanctions imposed on Russia as a result of the undeclared war in Ukraine are likely to cut Russian oil production in the next few months, belief that the Saudis will continue to cut production, and speculation that violence in Libya and Iraq will lower production from those sources.

Will any of this actually happen?

Good question. But those are the expectations built into oil prices—current spot and future—right now.